United States: Enforcement At The Gates: SEC Action Against Big Four Firm And New International Standards Highlight The Role Of Accountants As Financial Gatekeepers

Last Updated: November 11 2016
Article by Bret A. Campbell, J. Robert Duncan and Joseph V. Moreno

Most Read Contributor in United States, September 2017

In late September 2016, Andrew Ceresney, Director of Enforcement of the Securities and Exchange Commission ("SEC"), signaled the SEC's renewed focus on the key role played by audit committee members and external auditors as the "gatekeepers" of the financial reporting process.1  While stating that the SEC would not second-guess the good faith actions of auditors, he pledged that auditors and audit committee members who failed to reasonably carry out their responsibilities under applicable accounting standards would be held to task.2  In addition, just days before Mr. Ceresney made these remarks, the SEC made good on this promise by bringing its first enforcement action for an audit failure against a Big Four firm in nearly seven years, and its first ever independence-related action against auditors for maintaining overly close relationships with their clients.3  At the same time that the SEC was preparing this case, the International Ethics Standards Board for Accounting ("IESBA") issued new enhanced standards for when a professional accountant should report wrongdoing by a client, even when there is no legal or regulatory requirement to do so.  These developments highlight how regulators and industry groups, worldwide, expect accountants and auditors to serve as gatekeepers in preventing and reporting violations of law and securities regulations.

Audit Failures: Maintaining Professional Skepticism

On October 18, 2016, Ernst & Young LLP ("E&Y") agreed to pay more than $11.8 million to settle charges that it failed to adequately conduct an audit of its client, Weatherford International ("Weatherford"), permitting Weatherford to inflate its earnings and issue false financial statements in violation of U.S. Generally Accepted Accounting Principles ("GAAP").4

The SEC alleged that E&Y did not follow audit and professional care standards established by the Public Company Accounting Oversight Board ("PCAOB") and, as a result, failed to detect that Weatherford had overstated its earnings by use of deceptive non-GAAP intercompany tax accounting practices.5  These standards require, as part of the planning and execution of an audit, that auditors continually exercise professional skepticism with "a questioning mind and a critical assessment of audit evidence."6  Despite these standards—and regular reminders from E&Y's own National Office that expanded procedures were necessary to comply with PCAOB standards for audits of income tax accounting—the E&Y audit team failed to question numerous suspicious tax adjustments that were brought to its attention and instead relied completely on the client's explanation of them.7  According to the SEC, E&Y's blind acceptance of the client's unrealistic explanations also violated the PCAOB's principles of professional skepticism that warn that "an auditor should not be satisfied with less than persuasive evidence because of a belief that management is honest."8

Lack of Independence: Too Close for Comfort

About a month before the E&Y audit failure settlement related to Weatherford, E&Y also settled the first ever enforcement actions for auditor independence violations stemming from partner-client relationships.9  The SEC charged that the auditor-client relationships of two partners—one romantic—ultimately affected their independence.10  The SEC not only faulted the partners involved in the improperly close relationships but also the firm itself for failing to perform a reasonable inquiry or raise concerns about the relationships despite awareness of facts suggesting impropriety.11

Two separate actions were filed against two separate engagement teams—both involving independence impeding conduct stemming from too-close client-auditor relations.  The first action involved a romantic relationship between the engagement partner and the Chief Accounting Officer of the client.  The SEC noted that their relationship was "marked by a high level of personal intimacy, affection and friendship, near-daily communications about personal and romantic matters (as well as work-related matters), and the occasional exchange of gifts of minimal value on holidays such as Valentine's Day and birthdays."12  The second action occurred because of a client-auditor relationship that the SEC deemed to be excessively friendly.13  The conduct involved the relationship partner and Chief Financial Officer of the client taking frequent, overnight out-of-town trips, sporting events and socializing to "an excessive degree."14

In both of the independence failure actions, the SEC highlighted the auditor's role in protecting the public trust, and emphasized that it is the "auditor's opinion that furnishes investors with critical assurance that the financial statements have been subjected to a rigorous examination by an objective, impartial, and skilled professional, and that investors, therefore, can rely on them."15

International Focus on Gatekeepers

Outside the United States, IESBA recently issued a framework for auditors and other public accountants for responding to findings of Non-Compliance with Laws and Regulations ("NOCLAR").16  These standards aim to clearly set out what steps professional accountants should take "in the public interest when they become aware of a potential illegal act," and moves all professional accountants—not just auditors—onto the front lines "to protect shareholders and the general public from substantial harm that may stem from breaches of law and regulations." 17

Beyond existing legal and regulatory provisions governing how accountants should address NOCLAR, the new IESBA standards suggest that professional accountants may need to disclose illegal acts to appropriate authorities "even when there is no legal or regulatory requirement to do so."18  Such reporting obligations will require careful and in-depth legal analysis of complicated and competing duties of the professional accountant—protecting the public interest and maintaining confidentiality.  Indeed, these standards require that the accountant consider the legal and regulatory framework in the jurisdiction when responding to illegal acts, including examining whether the entity is in violation of anti-corruption and anti-bribery laws, is a systemic threat to financial markets, and even whether the entity is selling products that are harmful to the public health and safety.19  The expanded duty imposed on professional accountants by these standards necessitates involvement of legal counsel to determine close calls on legality and reporting.

In the United States, auditors have a responsibility to respond to illegal acts that are uncovered during the course of an audit.  Section 10A of the Securities Exchange Act of 1934 requires that auditors report findings of illegal acts to the client's management.20  After reporting, the auditor must assess the effectiveness of management's remediation of the illegal act, and if the remediation is insufficient or ineffective, the auditor has a duty to report the illegal act to the client's board of directors.21  Within one business day of the auditor's report to the board, the directors have an obligation to inform the SEC of the report and also notify the auditor that the SEC has been informed.22 If the entity does not meet this reporting obligation, the auditor must resign from the engagement and has a duty to directly inform the SEC.23

The new IESBA standards provide for a similar procedure for auditors to run detected illegal acts up the flagpole but now are more expansive and clear and apply to all professional accountants (i.e., Certified Public Accountants, Chartered Accountants).24  The standards provide for direct reporting to a regulator of detected NOCLAR for professional accountants engaged in services other than audits of financial statements and make it clear that reporting illegal acts directly to regulators in good faith, and after the exercise of professional judgment, is not considered a breach of the accountant's duty of confidentiality.25

Although the IESBA does not have an enforcement mechanism for its regulations, many of its standards later are adopted by other accounting regulatory bodies, such as the American Institute of Certified Public Accountants, and also are incorporated into laws and regulations in many jurisdictions.  The new NOCLAR standards are likely to make their way into standards from legal and regulatory bodies in many jurisdictions.


All professional accountants and auditors should be aware of their legal and ethical responsibilities with respect to reporting discovery of an illegal act, conducting a routine audit and ensuring a commitment to independence.  Corporations—especially those with extensive international operations—should be aware of the expansion of ethical and reporting obligations that are being placed upon its auditors and other professional accountants to proactively and diligently investigate any reports of NOCLAR.  This includes monitoring adoption of IESBA ethics rules in all jurisdictions in which it operates any accounting or financial function or where its internal or external auditors may be involved.  Professional accountants and auditors have always been on the front lines in their roles as public watchdogs and gatekeepers of the financial reporting process.  Going forward, the SEC and IESBA's actions signal a renewed focus on ensuring that they are fulfilling these roles and acting as the first line of defense against violations of securities laws and other related regulations.


1. See SEC Speech, The SEC Enforcement Division's Focus on Auditors and Auditing by Andrew Ceresney (Sept. 22, 2016), available at https://www.sec.gov/news/speech/ceresney-enforcement-focus-on-auditors-and-auditing.html.


3. See SEC Press Release, Ernst & Young, Former Partners Charged with Violating Auditor Independence Rules (Sept. 19, 2016), available at https://www.sec.gov/news/pressrelease/2016-187.html.

4. In the Matter of Ernst & Young LLP, SEC File No. 3-17628 (Oct. 18, 2016), available at https://www.sec.gov/litigation/admin/2016/34-79109.pdf.

5. Id.

6. PCAOB Auditing Standards AU § 230.01 (and AU § 230.07), available at https://pcaobus.org/Standards/Auditing/Pages/default.aspx.

7. Id.

8. PCAOB Auditing Standards AU § 230.09, see also AU § 316.13.

9. In the Matter of Ernst & Young LLP, Robert J. Brehl, CPA, et al., SEC File No. 3-17553 (Sept. 19, 2016), available at https://www.sec.gov/litigation/admin/2016/34-78873.pdf.

10. SEC Press Release, Ernst & Young, Former Partners Charged with Violating Auditor Independence Rules (Sept. 19, 2016), available at https://www.sec.gov/news/pressrelease/2016-187.html.

11. Id.

12. In the Matter of Ernst & Young LLP, Robert J. Brehl, CPA, et al., SEC File No. 3-17553 (Sept. 19, 2016), available at https://www.sec.gov/litigation/admin/2016/34-78873.pdf.

13. In the Matter of Ernst & Young LLP and Gregory S. Bednar, CPA, SEC File No. 3-17552 (Sept. 19, 2016), available at https://www.sec.gov/litigation/admin/2016/34-78872.pdf.

14. Id.

15. Id.

16. See generally IESBA Standard on Responding to Non-Compliance with Laws and Regulations, final pronouncement (July 14, 2016) available at https://www.ifac.org/system/files/publications/files/IESBA-Responding-to-NOCLAR-Pronouncement.pdf.

17. Press Release, IESBA (July 14, 2016) available at https://www.ifac.org/news-events/2016-07/iesba-redefines-accountants-ethical-role-when-laws-and-regulations-broken.

18. IESBA Standard on Responding to Non-Compliance with Laws and Regulations, final pronouncement, Section 225.29 (July 14, 2016) available at https://www.ifac.org/system/files/publications/files/IESBA-Responding-to-NOCLAR-Pronouncement.pdf.

19. Id. at 225.34.

20. Section 10A of the Securities Exchange Act, 15 U.S.C.A. § 78j-1 (West).

21. Id.

22. Id.

23. Id.

24. See generally IESBA Standard on Responding to Non-Compliance with Laws and Regulations, final pronouncement (July 14, 2016) available at https://www.ifac.org/system/files/publications/files/IESBA-Responding-to-NOCLAR-Pronouncement.pdf.

25. IESBA Standard on Responding to Non-Compliance with Laws and Regulations, final pronouncement, Sections 360.30 (July 14, 2016) available at https://www.ifac.org/system/files/publications/files/IESBA-Responding-to-NOCLAR-Pronouncement.pdf.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.